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    Apr. 23, 2015

Common Practices, Benefits and Drawbacks for Hedge Fund Managers of Using Target Returns (Part One of Two)

The use of target returns or performance targets by hedge fund managers in offering documents and marketing materials can potentially lead to negative consequences.  For example, Meredith Whitney’s Kenbelle Capital LP aimed for a target return of 12-17%; yet, when the fund returned -11%, BlueCrest Capital Management – its largest investor – filed a lawsuit to redeem its investment.  See “Citing Persistent Losses, Seed Investor BlueCrest Capital Sues Meredith Whitney and Her Hedge Fund for Return of Seed Capital,” Hedge Fund Law Report, Vol. 8, No. 10 (Mar. 12, 2015).  Other notable fund managers have lowered or revised their target returns in recent months, garnering negative press as a result.  Accordingly, hedge fund managers must take care when using target returns and first consider the potential risks and consequences of doing so.  This article, the first in a two-part series, discusses common practices for the use of target returns by hedge funds; analyzes reasons for using target returns; and highlights some potential drawbacks of using target returns.  The second article will analyze the legal risks associated with target returns and weigh the benefits of using target returns against such risks.

U.K. Disguised Fee Rules May Result in Increased U.K. Taxation of Investment Fees to Individuals Affiliated with Hedge Fund Managers (Part Two of Two)

Whilst the U.K. tax treatment of management fees relating to, and performance fees arising from, fund arrangements has been the subject of debate for some time, the recent introduction of new U.K. legislation has brought the issue into sharper focus in the United Kingdom.  Accordingly, hedge fund personnel operating within the United Kingdom may be affected by the new legislation and thus subject to increased taxation on fees and compensation earned with respect to their investment management activities.  In a guest article, the second in a two-part series, Sidley Austin partner Will Smith details exceptions to the application of the new legislation, known as the “disguised fee rules,” and discusses certain practical consequences which may arise under the new legislation.  The first article discussed the background and enactment of the disguised fee rules and provided a summary of their technical application.  For additional insight from Smith, see “Potential Impact on US Hedge Fund Managers of the Reform of the UK Tax Regime Relating to Partnerships and Limited Liability Partnerships,” Hedge Fund Law Report, Vol. 7, No. 10 (Mar. 13, 2014).  For insight from Smith’s partner Leonard Ng, see “Sidley Austin, Ivaldi Capital and Advise Technologies Share Lessons for U.K. Hedge Fund Managers from the January 2015 AIFMD Annex IV Filing,” Hedge Fund Law Report, Vol. 8, No. 12 (Mar. 27, 2015).  For insight from Sidley more generally, see “Sidley Partners Discuss Trends in Hedge Fund Seed Deals, Governance, Succession, Estate Planning and Tax Structuring (Part Two of Two),” Hedge Fund Law Report, Vol. 7, No. 37 (Oct. 2, 2014).

Is the Use of an Independent Valuation Firm Superior to a Manager’s Internal Valuation Process?

As private equity valuations have become subject to increasing review from investors and regulators, certain private equity managers have turned to independent valuation firms to assist in their valuation processes.  The practice, which can be expensive and time-consuming, can benefit managers with hard-to-value holdings.  However, the use of an independent valuation firm in addition to a manager’s internal valuation process remains above and beyond standard industry practice.  In a recent interview with Hedge Fund Law Report, Scott A. Arenare and Joseph P. Cunningham, partners at Willkie Farr & Gallagher and members of its Asset Management Group, shared insight on the use of independent valuation firms by private equity and hedge fund managers.  The interview specifically covered, among other topics, benefits of engaging independent valuation firms, trends in such engagements, allocation of independent valuation expenses and best practices for managers conducting internal valuations.  For more on valuation, see “Three Pillars of an Effective Hedge Fund Valuation Process,” Hedge Fund Law Report, Vol. 7, No. 24 (Jun. 19, 2014).

ACA Compliance Professionals and SEC Veteran John H. Walsh Share Insights on SEC Priorities for 2015

The SEC continues to hone its focus on investment advisers and funds, scrutinizing matters including firms’ compliance programs, conflicts of interest, cybersecurity and potential insider trading.  To that end, the SEC is conducting certain initiatives and employing various tools, such as data analytics and dialogue outreach.  A recent program presented by ACA Compliance Group offered the perspectives of three compliance practitioners about where the SEC will focus its attention in 2015.  It covered new and continuing SEC initiatives and the SEC’s use of quantitative analytics, highlighting areas of concern with regard to alternative mutual funds, fixed income managers, cybersecurity, conflicts of interest and insider trading.  The program featured Dan Campbell, Managing Director, and Joseph DiGiglio, a Principal Consultant, at ACA Compliance Group; and John H. Walsh, a 23-year veteran of the SEC and partner at Sutherland Asbill & Brennan.  See also “SEC’s Rozenblit and Law Firm Partners Explain the SEC’s Enforcement Priorities and Offer Tips on How Hedge Fund and Private Equity Managers Can Avoid Enforcement Actions (Part Three of Four),” Hedge Fund Law Report, Vol. 8, No. 2 (Jan. 15, 2015).  This article summarizes the key points raised during the program.

K&L Gates-IAA Panel Provides Comprehensive Overview of Cybersecurity Laws and Threats Applicable to Investment Managers (Part One of Two)

The frequency of large cyber breaches is increasing, as is the cost of responding to them.  A recent program sponsored by K&L Gates and the Investment Adviser Association (IAA) surveyed the current cybersecurity threat environment and SEC cybersecurity initiatives; summarized the applicable laws and regulations that bear on cybersecurity; considered the multitude of cybersecurity risks faced by investment managers; and offered a number of strategies for mitigating those risks.  The program was moderated by Mark C. Amorosi, a partner at K&L Gates, and featured a panel consisting of Jeffrey Bedser, CEO of iThreat Cyber Group; Laura L. Grossman, Assistant General Counsel of the IAA; Andras P. Teleki, a partner at K&L Gates; and E.J. Yerzak, Vice President at Ascendant Compliance Management.  This article, the first in a two-part series, summarizes the key points raised by the panel relating to the costs of cyber breaches; applicable laws and regulations; and cyber threats.  The second article will discuss the panel’s views on mitigating cybersecurity risks.  For more on cybersecurity, see “ACA Compliance Group Clarifies Misconceptions Commonly Held by Fund Managers with Respect to Cybersecurity,” Hedge Fund Law Report, Vol. 8, No. 15 (Apr. 16, 2015).

SEC Settlement Highlights Circumstances in Which Hedge Fund Managers Must Disclose Conflicts of Interest

The SEC has repeatedly emphasized the importance of proper disclosure of conflicts of interest to clients and fund boards.  In a recent speech, Julie M. Riewe, Co-Chief of the Asset Management Unit (AMU) of the SEC’s Enforcement Division, emphasized the continued focus of the AMU on conflicts of interest and postulated that the AMU would recommend a number of conflicts cases for enforcement action, including cases relating to undisclosed business activities.  See “Conflicts Remain an Overarching Concern for the SEC’s Asset Management Unit,” Hedge Fund Law Report, Vol. 8, No. 10 (Mar. 12, 2015).  This week, the SEC issued an order charging a registered investment adviser, along with its then-chief compliance officer, with breaching their fiduciary duties by failing to disclose a conflict of interest created by the outside business activity of one of the adviser’s top-performing portfolio managers and failing to disclose a breach of the adviser’s private investment policy by that portfolio manager.  This article provides a discussion of the SEC order and settlement, including the violations that the SEC claimed against the adviser and former chief compliance officer, then highlights the implications of the order for the hedge fund industry.  For another recent SEC enforcement action involving conflicts of interest, see “SEC Settlement Emphasizes the Importance – and Limits – of Fund and Transaction Disclosure,” Hedge Fund Law Report, Vol. 8, No. 13 (Apr. 2, 2015).

David L. Fitzgerald Joins Gabelli Securities

On April 21, 2015, Gabelli Securities, Inc. announced that David L. Fitzgerald has joined as general counsel and chief compliance officer of the firm’s alternative investment fund business, Gabelli & Partners, LLC.  Fitzgerald will also be responsible for compliance and legal oversight for GAMCO International SICAV, the firm’s Luxembourg-based UCITS fund business.  See “Credit Suisse Hedge Fund Survey Considers Factors in Institutional Investors’ Investment and Redemption Decisions, Appetite for Alternative UCITS and Anticipated 2015 Hedge Fund Investments by Strategy and Region,” Hedge Fund Law Report, Vol. 8, No. 12 (Mar. 27, 2015).  For more regarding general counsel and chief compliance officers, see “What Is the Value of Legal and Compliance Staff?  An Interview with David Claypoole on the Market for In-House Compensation at Hedge Fund Managers (Part One of Two),” Hedge Fund Law Report, Vol. 8, No. 10 (Mar. 12, 2015); and Part Two of Two, Vol. 8, No. 11 (Mar 19, 2015); and “Benefits, Challenges and Recommendations for Persons Simultaneously Serving as General Counsel and Chief Compliance Officer of a Hedge Fund Manager,” Hedge Fund Law Report, Vol. 5, No. 19 (May 10, 2012).

Ropes & Gray Expands Investment Management Practices in D.C. and Chicago

Ropes & Gray recently announced that David G. Tittsworth will join its investment management practice as counsel in the Washington, D.C. office in June; and former K&L Gates partners Paul H. Dykstra and Paulita A. Pike have joined as partners in its investment management practice in Chicago.  Tittsworth most recently served an 18-year tenure as president and CEO of the Investment Adviser Association.  See “K&L Gates-IAA Panel Provides Comprehensive Overview of Cybersecurity Laws and Threats Applicable to Investment Managers (Part One of Two)” above, in this issue of the Hedge Fund Law Report.  Dykstra and Pike represent mutual funds and fund boards in a broad range of matters, including corporate governance, reorganizations, compliance issues, and internal and SEC investigations.  For insight from the firm, see “Ropes & Gray Attorneys Discuss Implications for U.S. Hedge Fund Managers of the European Market Infrastructure Regulation,” Hedge Fund Law Report, Vol. 7, No. 27 (Jul. 18, 2014); “Ropes & Gray Attorneys Discuss the Impact on Private Fund Managers of Final Regulations Under the Volcker Rule,” Hedge Fund Law Report, Vol. 7, No. 10 (Mar. 13, 2014); “Tax and Structuring Considerations for Funds Organized to Invest in Master Limited Partnerships,” Hedge Fund Law Report, Vol. 6, No. 30 (Aug. 1, 2013); and “Ropes & Gray Partners Share Insights Gleaned from Successfully Navigating Presence Examinations with Hedge Fund Manager Clients,” Hedge Fund Law Report, Vol. 6, No. 10 (Mar. 7, 2013).

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